The values of European defense lag behind the reassessment of conflict beneficiaries

The enthusiasm of investors for European defense stocks has waned, as profit-taking and stretched valuations collide with increasing uncertainty about the future of war, with the conflict in Iran once again highlighting the effectiveness of low-cost drones.

The MSCI Europe Aerospace and Defense index fell by 9.2% in March, its sharpest monthly drop in five years, marking the beginning of an exceptional trade unwinding.

Defense stocks generally rise when a conflict breaks out – like after Russia’s invasion of Ukraine in 2022 – or when U.S. President Donald Trump pressures NATO allies to increase military spending.

However, this has not been the case since the Iranian conflict erupted on February 28, even though Trump has criticized NATO for its lack of support for American military actions.

“There has been a significant ‘de-grossing’ movement (reducing positions) as financial institutions and retail investors have sought to reduce their exposure in a context of increased uncertainty,” explains Martin Frandsen, portfolio manager at Principal Asset Management.

Shares of Czech arms manufacturer CSG have lost nearly a third of their value since the start of the conflict, while German companies Rheinmetall and Renk are down around 10% and Swedish Saab by almost 12%.

European defense stocks have been among the best-performing in the market since the invasion of Ukraine in February 2022, with a rise of over 450%, compared to about 40% for the MSCI Europe index.

This rally was fueled by promises from European governments to increase military budgets and Germany’s relaxation of budget rules last year to accelerate rearmament.

However, order intake has been slower than anticipated by some investors, with delayed or staggered contracts due to budget pressures in countries like France and the UK, according to Morgan Stanley analysts.

Rheinmetall, which produces tanks, ammunition, and anti-aircraft defense systems, stated that it was “inevitable” that countries would spend more on air defense as the war in Iran continues, but this has not been enough to stop the sector’s decline.

While investors remain generally positive, enthusiasm has waned and heavily crowded long positions have been reduced, according to a recent note from Citigroup. Overpositioning can amplify price movements when sentiment shifts.

“The start of the war in Iran, the sharp rise in energy prices that followed, and supply chain disruptions seem to have swept away all kinds of crowded trades,” analyzes Louis-Vincent Gave, CEO of Gavekal Research.

“Thus, just like gold, silver, copper, and other metals experienced an aggressive decline, defense stocks have followed the same path.”

Valuations have also weighed on the sector. At the start of the conflict, the European aerospace and defense index was trading at around 29 times earnings forecasts, close to a record set in late 2025.

“An increase in defense budgets over the coming years was already priced into global sector valuations,” notes Aarin Chiekrie, equity analyst at Hargreaves Lansdown.

“Consequently, the recent decline is partly explained by growth expectations that were overly optimistic.”

The conflict in Iran has highlighted both the cost and intensity of modern warfare, with Gulf states firing hundreds of American-made Patriot anti-missile interceptors, each costing around $4 million.

Concurrently, the war has reignited the demand for cheaper military solutions that have also gained importance in Ukraine, such as attack drones and drone interceptors, like the one developed by the Ukrainian Terra Drone, a subsidiary of Japanese Terra Drone.

“The question of the ‘future of war’ has shifted since the start of the conflict in Iran, with the growing role of new technologies like drones, which are much cheaper, challenging the demand for traditional, more expensive platforms,” explains Ciaran Callaghan, head of European equity research at Amundi.

Some European defense groups are heavily investing in drones, as well as in surveillance and anti-drone systems.

Rheinmetall, for example, reached an agreement with American Anduril last year to jointly develop European variants of Anduril’s Barracuda and Fury drones.

Despite the correction, analysts believe that the long-term investment thesis for European defense remains solid, with public spending commitments continuing to increase and capital flows suggesting selective buying on dips.

Data from LSEG shows net inflows of $1.32 billion into the WisdomTree Europe Defense ETF since the beginning of 2026, including $377 million since the start of the war in Iran.

Two smaller defense ETFs, the iShares Europe Defense and the HANetf Future of Defense, have together attracted $355 million this year, including $124 million since the start of the conflict.

“The long-term growth scenario remains intact… driven by the need for countries worldwide to rebuild their capabilities after decades of underinvestment,” concludes Aarin Chiekrie of Hargreaves Lansdown.